question archive consider a risky portfolio

consider a risky portfolio

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consider a risky portfolio. The end of year cash flow derived from the portfolio is either $-50,000 or $250,000 with equal probabilities of 1%. The alternative risk-free investment in T-Bill pays 6% per year.

  1. If you require a risk premium of 20% on such an investment, what the maximum you should pay?
  2. Imagine you pay the amount computed in 1. what is your expected return on this?
  3. Suppose that you expect 30% risk premium on such investment. how much are you willing to pay for this investment?
  4. Based on 1 and 3 above, what do you learn about your expected return and price paid for the risky assets?

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1.
=(0.5*50000+0.5*250000)/(1+6%+20%)=119047.619047619

2.
=6%+20%=26.00%

3.
=(0.5*50000+0.5*250000)/(1+6%+30%)=110294.117647059

4.
Higher the risk higher is the required return and hence lower is the price

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